Behavioural Finance Opens Path To Smarter Wealth Management (2024)

Tom Burroughes Group Editor 22 July 2019

This publication continues its series of articles about behavioural finance and how it is affecting wealth management.

An aspect of behavioural finance is that it arguably helps wealth managers to create the equivalent of a “flight simulator” for clients. Managers can throw a set of scenarios at a client, change their wealth “settings” (higher risk tolerance, sudden need for more money, change in personal circ*mstances, etc) and see how they react. Some of these ideas draw from computer games, so much so that the term “gamification” is used in the sector.

A firm that has pushed the envelope to some extent for getting clients to adjust and monitor their own views about money as part of the wealth journey is UK-based Seven Investment Management. This publication recently spoke to Terence Moll, who is responsible for investment strategy at 7IM. He joined the firm last year from Coutts, the private bank.

“Behavioural finance is becoming increasingly important. If you are going to help a client to look after their money then you need to understand the psychology of clients,” Moll said.

The firm has been looking at why people sell at certain periods, such as in February this year (a period of sudden selling) and how it might be able to change peoples’ minds.

“There is little understanding of the impact of informing clients [about behavioural finance] and how ignorance costs clients in the long run. In my meetings with clients they span the whole range [of awareness and ignorance],” Moll said. “On the investment side, we often think of markets in terms of who is buying and who is selling. There is an understanding of periods of panic where people sell at almost any price – and this can lead to opportunities."

7IM has already made quite a point of why behavioural finance matters as part of its intellectual toolkit, using it to drive some of its innovations in recent years. The firm’s app, My Future, which was built with the help of Nintendo gaming experts, is designed to help clients understand financial planning. A gaming tool, it shows users what sort of money they might have to live on, in some cases shocking people into changing course. Perhaps this app speaks to a behaviour that is all too common among humans: complacency.

Part of the problem with people, as shown when they regret losses more than perhaps they value the gains, is the pain of taking a hit to their portfolios, Moll said.

And that means that advisors need to manage client relations carefully, guiding them where necessary, such as during stressful market episodes, he said.

“You have to understand the pain people feel when they lose money and when they’ve made bad decisions,” he said.

A big change in recent years has been technology applying the insights of behavioural finance - with its roots going back decades - in daily investment life today, he said.

Perhaps a downside to tech, however, he said is that it also creates new potential dangerous temptations, such as allowing clients to churn portfolios unnecessarily, he said.

Technology can be used to replicate certain market events to test whether clients are as willing to bear risks as they say in an initial laying out of their views. Some people are more willing to bear risks than they might initially say, and others are less so, he said.

The discipline of behavioural finance also shines a light on a vital factor: risk and volatility are not identical. One can have a period of stable markets, followed by a sharp drawdown and permanent loss of capital – that is what risk is, he said.

Wealth managers vary widely in how much they understand about this area, Moll added, creating great potential for new learning. Some firms are making progress and others are still not thinking much about it.

“On one hand we have some IFAs who are very conversant with behavioural issues. On the other there are those in the industry who have very little understanding of this. There is little understanding of the impact of informing clients [about behavioural finance] and how ignorance costs clients in the long run. In my meetings with clients they span the whole range [of awareness and ignorance],” he said.

(To see another story about the behavioural finance issue, see here).